Have the markets rallied too far, too fast or is this only the beginning to a new major cyclical bull market? This is the question on many investors' minds after the 2nd quarter earnings season in the United States.
There are still many sceptics who argue that in the real economy has not much changed but with stimulation coming from virtually every possible source can the US led global recovery be far off ?
For every report that suggests the US economy has not been doing so badly or that the recovery is under way, another report puts a damper on that idea, including concerns about deflation expressed by Fed Chairman Alan Greenspan.
The past, throughout this entire supply-side cycle, has been a poor guide to economic activity. Whatever the status of the US economy it is clear that the Bush administration will continue to create stimulus every way it can in the 2nd half of 2003 to keep the money flowing and reduce the chance of deflation.
Remember that this rally is liquidity driven. The quick resolution of the war in Iraq was supposed to ease geopolitical tension and clarify the outlook for the US economy.
To many analysts and traders, the outlook for economic recovery is still clouded as is the longer-term consequences of the war itself.
President George W. Bush learned an important lesson from his father: You can win the war but still lose the election.
By almost all measures the war in Iraq was a great military success and a big boost for the political standing of George Bush initially until the reason that justified going to war - namely Weapons of Mass destructions that Iraq was supposed to have - almost evaporated when no such weapons were found even after several month of searching.
This has put President Bush on the spot and the world can't help wondering whether US military intelligence is really that bad or whether the public was misled just to get rid of Saddam Hussein and to have lower oil prices.
A strong US economy might make people forget about that, and achieving that goal is what permeates America's mid year economic outlook.
President Bush recognizes that to win the US presidential election of 2004, he must stimulate the economy as much as politically possible.
Many analyst expect that stimulus, sometimes referred to as the "Bush Push" in the 2nd half of 2003 will keep interest rates low, the US dollar on the weak side despite a declared "strong-dollar" policy, and the stock market on the rise as business conditions improve.
The latest fiscal stimulus comes in the form of the $350 billion tax cut, the majority of which will come, not surprisingly, before the November 2004 US presidential election.
The theory is that more money in the pockets of consumers should raise consumer confidence and spending, in turn boosting corporate earnings and the stock market. That would produce more tax revenue, offsetting the tax cut. However, spending or the lack thereof, is not the reason for this economic downturn. Therefore the sceptics of tax cuts point out that even more spending and encouraging consumers to go even more into debt is not the solution. The best solution for economic growth is to stimulate corporate formations and encourage the expansion of businesses. Only that creates jobs. It is the lack of jobs that is the real problem. However this time cutting tax rates on capital gains and dividends to 15% may do the job in encouraging businesses to invest. I expect that this time around Mr. Bush's tax cut "weapon" will spark an economic revival.
The stock market will go up (temporarily), the economy will get better (temporarily), people will have more money in their pockets (temporarily) and everything will be okay (temporarily).
Although the value of the US dollar has declined more than 20% from the 2002 highs relative to the major currencies, most notably the euro, no one in the Bush administration seems too unhappy about it. In fact, many appreciate what it is doing for US manufacturers, farmers and anyone else involved in exports, because a weaker dollar improves the US competitive position in world markets. That should boost earnings and the stock market valuations of US multinational corporations although there is some time lag between a weak dollar, earnings and capital spending.
Although oil prices have bounced up and down during the Iraq war, they have dropped below $30 a barrel level after threatening $40. If Iraqi oil comes on line and OPEC maintains production quotas so that inventories can be replenished, oil prices at the lower level will provide a boost for global economic improvement.
However, one area of concern for the US economy is the supply and price of natural gas, a situation that caused even Alan Greenspan to issue a strong warning recently.
As uncertainties in the crude oil market have increased, more industrial users have turned to natural gas, especially to generate electricity. If industrial production recovers and the weather is especially seasonal (hot summer, cold winter), then natural gas prices, already up +145% since January 2002, could spike to a new record high and pose a serious threat to the sustainability of the economic recovery.
Perhaps more than stocks, investors might consider Nymex options on Natural Gas as a leveraged bet on the recovery.
A lot of people are still questioning and doubting this rally as jobs growth is the missing element of the recovery so far, along with capital spending.
Because of this, we are climbing a wall of worry and that's what I feel will keep this rally going. Financial markets are ruled by bulls and bears, greed and fear. Fear of losing money and often more important; the fear of losing out.
Due to the massive stimulus, the economy and profit growth will pick up and when its does the bears for fear of losing out will aggressively shift their money into stocks, thus extending the rally.
There is a lot of pent-up demand for stocks and the fear of losing out rather then the fear of losing money will soon be the catalyst to propel share prices even higher.
In the final analysis, the "Bush Push" in the form of record low interest rates, a weaker dollar, lower fuel bills etc, together with increasing consumer confidence, greater spending, projections for stronger sales /earnings most probably will result in a brighter corporate profit picture and hence higher stock market indices in the medium term.
Later on Mr. Bush and the American people who most probably will re-elect him, will however pay a hefty price for this over stimulus.
The wide trade deficit, low savings rate and high debt levels will return to become reasons for concern and will result in a lower US dollar, weaker equity markets and investors switching back into bonds.
But for the time being (temporarily) the market embraces the Bush Push. The old adage holds true:
"Never fight city hall" (i.e. the government) and "the Trend is your Friend"
Michael Preiss is the Chief Investment Strategist for CFC Securities Ltd., a unit of Switzerland based CFC Group. He can be emailed on [email protected]
